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06/02/2015

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Quite on target, Ian. Executives invest their lives in their jobs, not their money. Mercenaries are not investors. Making them owners changes their employee value proposition in ways not always appropriate. Rewarding them over the long term like investors provides decidedly weak reinforcement effects because it lacks the certainty and immediate access of current income, even though it is preferred by shareholders, tax agencies and regulators. Ironic, that the very factors that persuade remuneration consultants to recommend at-risk schemes reduce the positive perceived values of both the recipients and the shareholders. It's difficult to spend hypothetical money, even though it may be begrudged by owners and the public.

Extensive re-thinking of objectives is required instead of merely grasping at new handy devices. Behavioral economists rather than tax accountants should become more involved in creating programs with better mutually beneficial positive impacts.

Excellent post Ian. The executive compensation proposition has become almost a rote exercise t many companies. The objective is the get the disclosable amounts right, rather than getting the programmes right for the company and individuals.

Added to this is the sheer size of some of the companies today. Aligning ownership for an individual to a company worth hundreds of billions of dollars with billions of shares of outstanding stock is a daunting task. Short of a complete reevaluation of the purpose and use of equity compensation, it is unlikely that a correction can be easily made.

That being said, if the market trends downward for any extended period (let's say 5-7 years minimum) this entire argument takes on a different complexion.

In a world dirven by (flawed) data and "best practices" any major changes are generally left to true outliers, while the middle huddles together and hopes the lions only get those at the outside edges.

Jim and Dan
Thank you for your kind comments.

Clearly there are problems with executive compensation, as you identify. Not least that executives are not instititional shareholders - and have different risk profiles. (Employees are dependent on their organisation for their total income, investors not so).

Change is needed and overdue. We will see!
Ian Davidson

Agree that change is needed. I would be interested to know what you might propose, although that's likely another article.

If longer time horizons reduce the immediate value (and reduce the power to drive the desired behavior) of bonuses to fractional amounts for the executive while increasing costs to the organization, it's a fair question to ask why we keep doing this.

Executive compensation exposure in my career to this point has been limited, so my suggestion probably carries a healthy dose of naïveté or may even rate a "because it's against the law, knucklehead" type of response. My organization is not publicly traded (at least yet). That said, I get a lot of value out of the articles and comments on this site, and would appreciate feedback, especially if I’m being a knucklehead with the suggestion below.

My thought is if there is a 5-year plan, why not break that up into 1-year increments? Offer a performance shares grant (based upon a specific dollar value, if possible) January 1 that will vest on December 31 according to the progress made against that year's goals. One could take an all-or-nothing approach, or establish a threshold where some percentage of shares would be vested for partial achievement of the goals with the remainder being forfeited, along with a schedule for potential upside. I’d guess that a payoff in 12 months’ time of a known amount might help increase the immediate value of the incentive for the executive and hopefully be a better driver of behavior. You might do away with long-term grants altogether, knowing that the 1-year grants are tied to the organization’s long-term planning. Perhaps such a plan may also be easier in some respects to account for and disclose properly.

Thoughts?

Thank you for your comment. What you suggest has been used by some organisations with varying success. At one level, pay systems are contingent. They must "fit" the orgasiation financially, culturally and organisationally, even differing business cycles.

My issue is that current executive compensation systems are broken to a greater or lesser degree. There is a dislocation between what is perceived as value by the different stake holders, executives, shareholders, accountants etc.

As you point out, often the key issue is variable performance pay over time periods, perhaps another article,,,

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